(Note: The author of this fundamental analysis is a financial writer and portfolio manager. He and his clients own shares of NFLX.)
Apple Inc. (AAPL) shares jumped by nearly 4.5% after it reported fiscal second-quarter 2018 results. Investors latched onto the massive $100 billion share repurchase, while also breathing a sigh of relief that iPhones sales didn't melt away, as many analysts and investors had feared. But perhaps the most significant piece of news from the latest results was the big jump in service revenue. That jump could be a significant paradigm shift for Apple, and more critically, a change in the way investors think about valuing the stock. (For more, see also: Apple's Stock Sharp Decline May Be an Overreaction.)
Where would Apple's stock price be today if investors started valuing Apple as a subscriber growth story, like Netflix Inc. (NFLX), with a recurring revenue stream? Probably not trading at 13.7 times fiscal 2019 earnings estimates of $13.08 per share. The market has demonstrated time and time again it is willing to pay a much higher multiple for subscriber growth than hardware growth.
More Than Double
Netflix trades at nearly 67 times 2019 estimates, and 6.8 times sales estimates. Meanwhile, Apple trades at only 3.3 times one-year forward sales estimates, and 13.7 times earnings estimates. At a Netflix-like sales multiple, Apple's stock would be worth more than double its current value—and its market cap would soar to nearly $1.8 trillion.
The analysis above is not a fair comparison, because Apple sells slower growing iPhone and other products that also have a more cyclical nature, versus a steady subscription model. But it may also suggest that at some point in the future, the market may start valuing the company as more than just a hardware maker, but also as a service provider. This would likely lead to a re-rating of the stock, upping its valuation.
Big Service Revenue Jump
Apple announced a big jump in service revenue during the quarter, rising by 31% versus the same period a year ago, an increase of 8% sequentially. More critical, service revenue climbed to represent about 15% of total revenue, up from 13% in the same period a year ago. The company also announced on the conference call it had nearly 270 million paying subscribers, of which 40 million subscribers are for the Apple Music service.
Already Bigger Than Netflix
Apple's service revenue in the first two quarters of the year has already surpassed Netflix's estimates for the entire year. The company has reported total revenue of $17.6 billion, while Netflix is forecast to grow revenue to $16.1 billion in 2018. (For more, see also: Why Apple's Stock May Have Peaked.)
Apple is also generating more revenue per user, based on the data provided in the release and the call, at nearly $12.25 per month, versus Netflix's $9.87 per month.
One needs to think that over time, as service revenue continues to grow and become a more significant part of total revenue, the way investors value Apple will start to change as well. It may not be a Netflix type of valuation, but it likely comes at a much higher prices than its current valuation.
Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer's bio and his portfolio's holdings. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.